Balance of Payments: causes and what are the corrective measures by VEDANT JAIN at LEXCLIQ

Balance of Payments is a systematic record of all economic transaction of residents of a country with the rest of the world during a financial year. BOP a/cs are maintained as per the provisions of the double-entry book system accounting system under these two equal entries i.e. debit & credit are made in the accounts for every transaction. Since the sums of debits and credits are always equal, so BOP accounts are always in balance in the accounting sense.

Cause of Adverse BOP

Undertook Development Activities – Developing countries undertake developing activities and for that, they need technical support and modern machines to undertake that developmental activity so that’s why they need to depend on the advanced nations for their supply. This leads to an increase in imports which affects the balance of payment of a country and causes disequilibrium.

High Inflation – Increased inflation leads to higher price of the domestic goods which ultimately benefits foreign goods which become relatively cheaper compared to domestic goods thus, it leads to an increase in imports which affect the BOP of a country therefore central bank need closely monitor inflation rates.

Cyclical Fluctuation – When the economy is in good health and experiencing a boom, then the domestic demand increases but the domestic production is unable to meet those demand and therefore the country needs to import which leads to a BOP deficit.

Low Demand in exporting nation – When demand for domestic goods in the foreign country decreases then it leads to falling in exports which ultimately have an adverse balance of payment of exporting country.

Importing of Services – When a country imports services from another country that it itself cannot render then the money is to be paid (outflows) by the importing which can also adversely impact BOP.

Political Factors – Political instability is one of the biggest factors causing BOP disequilibrium that may happen due to large outflows and low inflows. Unstable govt. and less support for its economic policies can lead to demotivation of investors and thus decreases inflows. This ultimately led to adverse BOP.

Corrective measures of Adverse BOP

Deflation – It is one of the important tools to correct adverse BOP which can be achieved by expanding exports and reducing imports. If inflation is low which means a fall in the price of commodities thus increasing exports of domestic goods in foreign countries. increased exports can correct the BOP of a country. deflationary measures can be implemented by the central bank.

Monetary Policy Measures – It is the central purpose of the central bank to keep inflation in control of the economy. Reduced prices and lower interests’ rate can give a big boost to the manufacturing sector which can exports goods at lower prices and thus earns increases in foreign reserve. This whole process can lead to favourable BOP.

Trade Policy Measures – It is the primary tool of a govt. uses when it wants favourable BOP. This measure includes adopting trade policies that increase exports and decrease imports. Exports are encouraged by reducing export duties and by giving subsidies to manufacturer and traders. Govt. can further motivate exports by imposing lower taxes on the income earned by exporters.

Fiscal Policy Measures – This measure can be adopted by increasing the existing tax rate or imposing new taxes and saving govt. spending on non-developmental and unproductive projects. By having more money with the ex-chequer can correct adverse BOP.

Devaluation of National Currency – It means reducing the value or exchange rate of a national currency with respect to other foreign currencies. By doing this good which is to be exported their prices go down and imported goods prices go up. This results in encouraging exports and reducing imports which leads to favourable BOP.

Exchange Controls – This can be done by ordering all exporters to surrender their FOREX to the country’s central bank and only rationed among the licensed importers. Only licensed importers are allowed to import. However, this measure is an extreme measure and done in an extraordinary situation to bring equilibrium and favourable BOP by rectifying limited imports.

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